Will New Appraisal Standards Wreak Havoc on Your Home Value?

Friday, May 8, 2009 | Ethan Roberts

On Monday morning, stocks rose strongly on word that pending home sales were up 3.2% in March. On CNBC.com, they even went so far as to state that this supports the view that the housing market is close to hitting a bottom.

Lawrence Yun, the chief economist of the National Association of Realtors, and one whom I have often disagreed with in my Tycoon Report articles, was quoted as saying:

"We need several months of sustained growth to demonstrate a recovery in housing, which is necessary for the overall economy to turn around."

For once, Mr. Yun (who now sounds much more realistic in his estimates than in recent years) may be on the right track. His fluffy, overly optimistic predictions in the past two years were laughable, as though the subprime meltdown (and subsequent worldwide economic upheaval) were just some pesky mosquitoes one could simply shoo away.

2007: Mr. Yun reassures homeowners that
the market is just suffering a slight correction,
and that home prices will rebound soon.

But here in the real world, something very troubling has recently developed in the real estate market. Real estate appraisers are now being instructed by lenders to use comparable sales that are ...

... NO OLDER THAN 90 DAYS AND NO FURTHER THAN 1.5 MILES FROM THE SUBJECT PROPERTY.

Let's think about what this means for a few minutes.

We know that sales in the last three months have picked up a little bit. However, about 30%-40% of them have been either heavily discounted foreclosures or short sales.

Bargain-hunters have definitely been on the prowl. This means that many of the comparable sales for any home that is going into pending status today will come from this large group of distress sales.

Bargain Buyer Beware

I just finished a phone call with my mortgage officer. He told me that he recently had this exact situation on one of his loans, and it killed a potential sale.

Both the buyers and sellers of a regular re-sale agreed to a $420,000 selling price, but when the appraiser searched for recent sales within the new parameters described above, all he could find was one short sale for $370,000.

Because there were no other sales at a higher value, now the lender will not approve the loan on a sale price above $370,000!

This is crazy!

Ethan reacts to new appraisal rules...

For years, even well before the real estate market went into "bubble" mode, the appraisal standard was to use comparable sales from the prior six to 12 months, and one could search within a two-mile radius from the subject property.

However, safeguards were still in place. An appraiser had to use any closed sales from the same neighborhood first, before being able to branch out to the two-mile radius.

And recent sales were still given priority to a sale from 10 or 11 months back. These rules were regarded to be both fair and as contributing to reliable home values.

Revised Appraisal Standards Grazing the Limbo Bar

However, the new standards are capricious and arbitrary, and could very well force the general market to come down to where foreclosed homes are currently priced. This would have several negative effects upon the real estate market:

1) Many people who need to sell will be forced to take their homes off the market because they will be "upside-down" (i.e. owing more than the sale price) if they have to sell at appraisal price. These are not people who are behind in their mortgages, or in any way in need of a short sale. They simply will not be able to sell.

2) Some sellers who are current in their payments, yet unable to sell at the lower prices, will just decide to let their home to go into foreclosure, or will ask their lender to consider a short sale. This will increase the distress numbers and lead to further downside pressure on home prices. Since no lender will do a short sale without the homeowner being at least three months in default, this will force people who previously had excellent credit scores, to ruin their credit by purposely defaulting on their loan.

3) People who need to sell their homes in order to buy another home may find themselves unable to do so, even if the home they are buying also becomes cheaper. Without a profit from the first sale, they will lack the down-payment money necessary to purchase the next home.

One "solution" to this problem, as I suggested to my mortgage broker, is to make mention of distress sales on the appraisal, but to modify the value of the distressed comparable for "condition."

An appraiser can get a general idea of the condition of a previous sale by looking up the old listing, or by talking to the agents involved in the sale. Then they can simply adjust the value according to what the property needed, at the time of the sale.

For example, a foreclosure missing a refrigerator, stove and dishwasher would be adjusted by $1,000-$2,000, depending on the standard of that neighborhood.

Most foreclosures need some kind of work, whether it's structural or just cosmetic. Many were neglected by the former owner, due to lack of funds. Some have missing appliances, light fixtures, hot water heaters, air conditioning units, etc. And there are those that have been vandalized.

Vandalism in a foreclosure in Fort Myers, Fla. ...

Now, imagine for a moment that you are selling your home in the same neighborhood as the picture above, and that your kitchen was remodeled a few years ago. With a beautiful kitchen, you are trying to get as much as the market will bear. Perhaps your kitchen looks something like this:

But unless values are adjusted to reflect the conditions of the foreclosures, your kitchen (and subsequently your home) will command no more value than the vandalized home shown above!

Nice, huh?

Shouldn't YOUR lovely, well-cared-for home be worth more than some boarded-up, trash-infested foreclosure down the road?

So, yes, Mr. Yun -- it is going to take several months of sustained growth to get to where we need to be. But it's going to take a lot more than just seducing first-time homebuyers with low interest rates, lower prices, and that $8,000 tax credit.

It would be easy for me to suggest that NAR put pressure on the lenders to ease up their chokeholds on appraisals and lending. But, let's face it, the lenders are scared to death right now, trying to loan money to people in a declining market.

Unfortunately, they are creating a catch-22 by forcing prices down even more, thus throwing everyone who bought a non-distressed re-sale within the last six to 12 months into negative equity.

Pending Sales Don't, Won't Always Result in an Actual Sale

If you are considering buying a home, the low interest rates and $8,000 tax credit are certainly appealing, but you had better look for a home with equity protection as well. Short sales are slowly improving, as lenders become a bit more flexible on prices, but foreclosures still remain the most economical way to go. Just make sure you buy one that doesn't have too much wrong with it, or the mortgage company may also refuse to loan you the money!

As for CNBC.com, methinks they do exaggerate a bit in saying the housing market is close to hitting a bottom. At best, that's a long shot, not unlike the 50-to-1 odds of the Kentucky Derby winner last Saturday.

As I keep reminding everyone, pending sales are just that ... pending. Lots of folks are still getting shot down in underwriting, or will be soon by the new appraisal guidelines. Remember, "pending" means nothing until all parties are at the closing table, signing on the dotted lines, and exchanging keys!

Long shot, "Mine That Bird," at 50-to-1 odds,
crosses the finish line to win
the 135th running of the Kentucky Derby ...

See you next week!

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Ethan Roberts
Chief Investment Officer
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